CoPS/IMPACT Working Paper Number G-282

Title: The Effectiveness of Investment Stimulus Policies in Australia

Authors: J.M. Dixon and J. Nassios

Abstract

We present the results of three economic modelling simulations of changes to tax policy intended to
stimulate investment in Australia. We begin with a comparison of a company tax cut and an
investment subsidy, both unfunded and calibrated to yield equivalent Federal Government budget
impacts. Our key findings (summarised below) illustrate that an investment subsidy is a more
effective policy instrument for stimulating investment and improving domestic welfare:

1. With both policies calibrated to the same budgetary cost, the investment subsidy is more
effective in raising the volume of investment;

2. The investment response to a company tax cut is skewed towards foreign investors, while the
investment response to an investment subsidy is equitably proportioned across foreign and
local investors;

3. The company tax cut induces an increase in net foreign liabilities and associated servicing costs
while the investment subsidy has little long-term effect on net foreign liabilities;

4. Both policies lead to increases in gross domestic product (GDP), employment and real pre-tax
wages; and

5. The impact on gross national income (GNI), an indicator of domestic material welfare, is
positive for the investment subsidy but not for the company tax rate cut.

In a final simulation, we revisit the investment subsidy to assess the net impact when the policy is
fully funded. While many potential funding models exist, herein we assume partial funding via the
denial of cash refunds of franking credits, with the remainder of the funding sourced via a small
increase in economy-wide average personal income tax. We find that the investment subsidy still
leads to a long-term gain in domestic welfare. When fully funded in this manner:

8. The investment subsidy still returns positive results for employment, GDP and the real pre-tax
wage;

9. The long-term gain in real post-tax wages is lower than in the unfunded case, but it remains
positive; and

10. Fully funded, the investment subsidy still leads to a long-term gain in GNI.

Based on these results, we strongly recommend that policy-makers consider an investment subsidy
instead of a cut to company tax as a better value-for-money policy initiative to increase both
investment and domestic material welfare.